Commentary and musings on the complex, fascinating and peculiar world that is securities regulation

Sunday, November 06, 2011

Bi-Partisan Amendment Preserving State Police Powers in Crowdfunding Legislation Explained in House Colloquoy

The House overwhelming passed legisaltion, HR 2930, allowing companies to pool up to $1 million without the expense of registering with the SEC or up to $2 million if the company provides investors with audited financial statements. Individual contributors are limited to $10,000 or 10 percent of the investor’s annual income, whichever is less. The Entrepreneur Access to Capital Act was sponsored by Rep. Patrick McHenry (R-NC, Chairman of the TARP and Financial Services Subcommittee.

A bi-partisan deal preserving state enforcement authority allowed the crowdfunding legislation to move forward, but according to some did not go far enough in preserving the power of state authorities. The Perlmutter-McHenry Amendment ensures that state securities regulators have the means to police fraud, deceit, misrepresentation, and other unlawful behavior to protect investors. Since state securities regulators already have the resources and expertise to examine unlawful behavior at a micro-level, it is essential that this legislation recognize and authorize them to continue to fight unlawful conduct. The powers of state securities regulators for crowdfunding are no different from what that which they have for any covered security. Cong. Record, Nov. 3, 2011, p. 7306

Explicating further, Rep. Perlmutter said that the structure of the legislation is such that an issuer can solicit small investments via the Internet or some other mass type of media, and that solicitation then, a notification is made to the SEC. Once that notification is made, then notice of the solicitation on the Internet, this crowdfunding is then given to each state so that the state regulators, the state enforcement authorities, are given notice of this solicitation, of this crowdfunding request for sale of securities. The Perlmutter-McHenry ensure that when the states get this notice, they can use their police powers, their enforcement authority, to ensure that the issuer, or anyone involved with the solicitation, anyone involved with this crowdfunding which is being used across the Internet, can then, the laws can be enforced to stop any kinds of fraud, defalcation of funds, embezzlement, misrepresentation, any kinds of bad acts related to the solicitation under the crowdfunding. This applies to both the issuer and the intermediaries. Anybody holding the funds will still be subject to the police powers of the state. So Congress, in the legislation, maintains the states’ rights for police power. Cong. Record, Nov. 3, 2011, p. 7306

According to Rep. Melvin Watt, the Perlmutter-McHenry Amendment still preempts state law and fails to address the fundamental concern that states have had with H.R. 2930 since its introduction, which is the preemption of state authority to review securities prior to their offering. Rep. Watt inserted into the record letters from the North American Securities Administrators Association to House Speaker John Boehner and a letter from North Carolina Attorney General Elaine Marshall, essentially making the same point as the Representative.

In its letter NASAA said that the legislation, while well intended, was structurally because it would needlessly preempt state securities laws and weaken important investor protections. H.R. 2930 would preempt state laws requiring disclosures or reviewing exempted investment offerings before they are sold to the public., said NASAA, adding that the authority to require such filings is critical to the ability of states to get ‘‘under the hood’’ of an offering to make sure that it is what it says it is. In her letter, Secretary Marshall said that H.R. 2930 contains a preemption provision that would prohibit her agency from requiring the filing or disclosure of information about these investment opportunities before they are offered to the public in North Carolina. She believes that enacting this preemption would be a serious mistake. Cong. Record, Nov. 3, 2011, pps. 7307-7308

In response, Chairman McHenry said that crowdfunding will not work without the exemption from individual state registration. It is a very key part of the process. When it costs $150 to register a security in Connecticut, explained the sponsor, and all you’re trying to do is raise $150 from Connecticut, you net zero. And beyond that, asking a lawyer to file the paperwork. The intent of the legislation is to preserve state antifraud enforcement, which the states do very well. According to Rep. Perlmutter, the purpose of the state exemptive provision is to have in effect a national solicitation notification nationally to the SEC, and then the powers of the states kick in, as opposed to individual notification state by state. In order to make crowdfunding work, there has to be a structure allowing for the national offering, notice to the states, and then the states’ police powers kick in. And the SEC has its police powers as well if there is any fraud, manipulation, or misrepresentation. Cong. Record, Nov. 3, 2011, pps. 7307-7308.